It's not how big the deficit grows, it's how long it lasts

How worried should we be about a $50-billion deficit?

It's not how big the deficit grows, it's how long it lastsFinance Minister Jim Flaherty’s admission that the federal deficit is metastacizing to $50 billion or more this year, way up from the $33.7 billion he projected in his Jan. 27 budget, isn’t really all that disturbing—if you believe such staggering deficits won’t last more than a couple of years.

After all, deficits are supposed to be good for what ails our economy right now. The global policy response to the recession was to embrace the Keynesian fix: inject government stimulus to shore up the economy until spending by companies and consumers picks up again.

But that’s a prescription for bad times. When the slump is over, the deficits are supposed to shrink again, hopefully disappear. And exactly how our federal government will get back in the black is not entirely clear.

Consider our recent experience of a transition from deficit to surplus—the Liberal government’s success back in the late 1990s in banishing the deficits that had become a way of life in Ottawa. Conventional wisdom will tell you it was tough spending restraint imposed by Jean Chrétien and Paul Martin that did the trick. In fact, revenue increases played a much bigger role.

And looking ahead, it’s an uncertain revenue outlook that makes the current government’s plunge into deep deficits quite troubling. First, here’s what you need to know about the 1995 and 1999 period when the Liberals balanced the books: federal spending shrank 5 per cent over those years, while revenues soared 26 per cent, including a stunning 39 per cent rise in corporate and personal income taxes.

So, as Prime Minister Stephen “Maynard” Harper puts its faith in record deficits, can his government rely on tax revenues, in the better days ahead, to again rebound robustly enough to repair a tattered balance sheet?

After putting some questions to Derek Burleton, director of economic analysis for the TD Bank Financial Group, I’m not at all confident revenue growth will be big enough this time to do the trick. Here’s part of our telephone conversation:

Q. Now we know deficits are going to be far bigger than we were told only a few months ago. How believable are the government’s plans for keeping them temporary?

A. It’s probably going to prove more challenging to rein in the deficit than the government indicated in the budget. I think the deficits will come in higher and over the longer term the revenue growth is going to be slower.

Q. You mean the anticipated rebound in corporate and personal tax revenues might not be as strong as expected?

A. Look at the [Jan. 27] budget. They banked on revenue growth in the order of seven per cent on average over the medium term. That’s lofty. I’d feel more comfortable with something in the realm of five, five and a half per cent.

Q. But as the economy starts expanding again, why not expect the sort of boom in the tax haul that the previous Liberal government enjoyed?

A. In the late 1990s there was the IT bubble, so revenues went through the roof. They went through the roof again in the first half of this decade, and even beyond that, as commodities were growing. Then you add on top of that resilience in other sectors, and it’s been an excellent growth streak for government revenues since the late 1990s, with the exception of a couple of off years.

Q. And you don’t see similar heady days ahead?

A. The economy could be in for a sub-par growth period over the medium term. I tie it to the U.S., which is our primary trading partner. Don’t get me wrong—I certainly think that we’re better off than the U.S. in many regards, not facing the same challenges in consumer indebtedness, and fiscally we’ll get out of the recession in much better shape.

Still, the U.S. worries me. Three negative things from the U.S. are going to stretch out beyond 2010. All the government borrowing they are going to have to do is going to keep interest rates up, and we can’t separate ourselves from that. The weaker U.S. dollar is going to keep the Canadian dollar up. And just the relatively weaker recovery in the U.S. market. Those are the big three.

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